Territoriality and the Original Intent of Subpart F

12 Pages Posted: 22 May 2017 Last revised: 25 May 2017

Date Written: May 20, 2017


On April 26, 2017, President Trump issued a one-page tax reform outline that included “territoriality,” i.e., exempting from tax dividends from the non-Subpart F income of controlled foreign corporations. Territoriality is also included in the House GOP “Better Way” Blueprint and was supported by the Obama Administration and in bipartisan legislation introduced in 2016 by Senators Rob Portman (R-OH) and Chuck Schumer (D-NY). Thus, of all the current tax reform proposals, it may have the best chance of being enacted, especially given that it is linked with imposing some tax on the past offshore earnings of US multinationals.

In the course of investigating the Stanley Surrey papers at the Harvard Law School Library, I discovered an interesting document that can shed some light on the “original intent” of Subpart F and its relation to territoriality. The document shows that in Surrey’s view, the purpose of Subpart F was primarily to prevent shifting of profits from the US to low-tax foreign jurisdictions such as Switzerland. This task is needed to achieve CEN, protect the gold reserves in Fort Knox, and prevent non-taxation of US source income. The emphasis throughout is on the low tax level in the foreign country, because in the absence of such a low tax level, deferral does not confer meaningful tax benefits, and does not violate CEN, create balance of payments problems, or induce base erosion and profit shifting out of the US.

Territoriality would exacerbate the profit-shifting problem by lifting the only current constraint on it, which is the difficulty of repatriating the offshore income. Surrey would be appalled at the current ability of Apple, Amazon, Google, Facebook and Microsoft to do exactly what he opposed in 1961, namely “license United States created patents and know-how” from tax haven CFCs without triggering US tax.

Ideally, we should go back to the drawing board and adopt Surrey’s original 1961 proposal to abolish deferral. But since that seems politically impossible (even though the president proposed it during his campaign), we should at least do what every other OECD country that has CFC rules has done- combine territoriality with a strong minimum tax provision, either explicitly or by listing certain countries as tax havens. That, and not the current territoriality proposals, would “level the playing field” between US and foreign multinationals.

Keywords: Territoriality, Subpart F

JEL Classification: H26

Suggested Citation

Avi-Yonah, Reuven S., Territoriality and the Original Intent of Subpart F (May 20, 2017). U of Michigan Law & Econ Research Paper No. 17-007, U of Michigan Public Law Research Paper No. 557, Available at SSRN: https://ssrn.com/abstract=2971410 or http://dx.doi.org/10.2139/ssrn.2971410

Reuven S. Avi-Yonah (Contact Author)

University of Michigan Law School ( email )

625 South State Street
Ann Arbor, MI 48109-1215
United States
734-647-4033 (Phone)

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